Until the early 1980s, the dominant form of retirement income plans sponsored by corporations for their employees within the United States were defined benefit plans. Under defined benefit plans (DB plans), the employee's retirement benefits are amounts guaranteed to the departing employee and are insured by the PBGC. The employer's ongoing contribution to the plan is determined actuarially. Since 1974 and the enactment of ERISA, there have been at least fifteen legislative acts impacting qualified pension and profit sharing plans. Much of this legislation has made defined benefit plans less and less attractive for employers to sponsor and have made defined contribution plans more and more attractive. By far the most popular type of non-defined benefit qualified retirement plan to emerge during the past fifteen years is the 401(k) plan. These plans can be structured several ways and can optionally be either a profit sharing plan or an ESOP (employer stock ownership plan) plan. They allow employees to contribute an allowable percentage of pretax income into the plan, making them a very attractive long-term savings vehicle for retirement. Further enhancing the appeal of 401(k) plans for employees, is the ability for employers to make an optional matching contribution. Most 401(k) plans provide an employer matching contribution of some kind and allow employees to be pro-active in selecting the investment direction of their accounts. Employers are particularly pleased with the heightened awareness employees tend to have about the value of the 401(k) benefit plan. Employees often pay less attention to and appreciate less defined benefit plans—despite the fact that they may cost the employer more and prove more valuable to the employee. In addition to the above, employers have become aware of the costly nature of all employee benefits (i.e., due to the impact of medical inflation on medial benefits and the accounting rule changes impacting retiree medical and life plans—FASB statement 106). Consequently, employers are becoming increasingly cost conscious about all benefit offerings.
One of the effects of the recent trends in employee benefits described above, is that there are currently over 30 million employees participating in 401(k) plans—in 1974 there were none. Additionally, there has been an enormous increase in the number of highly compensated employees participating in non-qualified retirement plans due to benefit restrictions in qualified plans.
A common feature in defined benefit pension plans is a disability completion benefit. If the plan participant becomes disabled prior to retirement, the employer is obligated to continue funding on the employee's behalf until retirement. The employee is entitled to approximately the same level of retirement income as they would have received absent the disability (small differences are possible since salary increases between the date of disability and retirement must be estimated). The point is under defined benefit plans there is an established practice of providing an undiminished level of retirement income to employees who become disabled during active employment years.
In contrast, employers offering defined contribution pension and profit sharing plans have not historically provided an undiminished retirement benefit in the event of disability. Because of the recent shift from a pre-dominate reliance on defined benefit plans to more and more reliance upon defined contribution plans, millions of American employees are at risk of losing a significant portion of their retirement benefits in the event of disability (spouses and dependents are also at risk).
There are many ways to protect employees from this risk. For example, employers may be able to continue making contributions on behalf of a disabled employee. However, there are several legal hurdles that make this difficult to accomplish. IRC Code Section 415(c)(3)(c) includes a definition of disability that prevents employers from providing adequate benefits for the majority of disabled employees. If the employer does provide a disability benefit, they can either self insure the risk or insure it.
There are many different ways that insurance can be structured to cover the risk of losing defined contribution plan retirement benefits. For example: (1) the employer can pay for coverage either within the defined contribution plan or outside of it; (2) the employee can voluntarily purchase coverage either within the defined contribution plan or outside of it; or (3) the employer and employee can share the expense for coverage either within the defined contribution plan or outside of it.
In addition, the policy of coverage can be provided under either a group or individual contract. Coverage can provide either immediate benefit payments (payments made at the time of disability), or deferred benefit payments. If immediate, the benefit payments can be made internal or external to the defined contribution plan in a number of ways. In the final analysis such coverage will be structured according to the particular needs and desires of each sponsoring employer and the specific (legal and other) requirements of their existing benefit plans.
Given that this represents a huge existing marketplace for insurance companies in the disability insurance market, it is interesting to note that none have successfully entered it on a significant scale. There are no serious underwriting risks blocking entry into the market. The concern for “over-insuring” is easily offset by restrictions on the disabled person's ability to access funds prior to retirement. Some carriers have, on a very limited basis, provided coverage to highly compensated employees external to defined contribution plans. While coverage is underwritten with the intent to protect defined contribution plan retirement benefits, the policies used thus far have been policy forms that were originally designed and priced to cover other loss of income risks.
To date, disability policies have not been made available to the entire employee population of a defined contribution plan—either within the defined contribution plan or external to the plan. To date, disability policies have not been made available to participants (either to all plan participants or even a sub-grouping of plan participants) within a defined contribution plan.
Historically, disability policies offered to protect participant contributions (employer and or employee paid) to defined contribution plans, have been made available only on a very limited basis (i.e., never offered to more than ⅓ of a plan's participants). Additionally, they have only been offered external to the defined contribution plan. Less than 100 of these limited, external employer sponsored plans have been underwritten during the past five years. Only two or three carriers have been willing to offer polices to defined contribution participants. This coverage has been offered on a guaranteed issue basis. Other carriers are not prepared to offer individual policies on a guaranteed issue basis.
One major insurance carrier, a leader in offering administrative services for 401(k) plans, attempted to make a disability policy available to 401(k) plan participants. They were forced to withdraw the product from the market shortly after introduction. Their outside legal counsel discovered that the way they structured the policy offering within the 401(k) plan caused the 401(k) plan to be in violation of ERISA rules—thus subjecting the sponsoring employer to potential fines or plan disqualification.
Another leading disability carrier attempted to market a rider to their existing group long term disability (LTD) plans. The rider would be purchased voluntarily by persons covered under the employer sponsored LTD plan who were also participants of a 401(k) plan. The rider was designed to protect 401(k) contributions. Thus far, interest in offering the rider to employees has been minimal. In the few situations where employers have consented to allow the carrier to offer the rider to their employees, participation has been extremely low. The carrier considers the entire initiative a failure and is seeking other ways of making coverage available so that participation reaches more successful levels.
Most defined benefit plan disability protection offered by employers is self-insured. Annual plan contribution levels are determined actuarially. The amount needed to fund for current and future disabled participants is included in the actuarial formulas. Therefore, disability insurers have not developed computer systems to cover all employee participants of defined benefit pension plans.
In most of the established disability markets (both group and individual) the policy is sold to the covered person directly or is sold to them indirectly through some form of sponsorship—an employer makes coverage available to employees or an association makes coverage available to members. Employers also provide coverage on a non-contributory basis to employees. In all of these situations, the insurance carrier usually has to deal with only one, two, or three parties at most:    1. The covered individual if coverage is sold to them directly;    2. The covered individual and employer (or association) if coverage is sold through employer (or association) sponsorship—whether contributory or non-contributory; or    3. The employer if coverage is provided on a non-contributory guaranteed issue basis.
In addition to the above, the insurance carrier may work with a trustee of a welfare benefit trust established by the employer or association. Insurance companies may also use third party administrators to perform some or all of the administration associated with offering traditional disability coverage. Historically, the computer systems used to provide disability coverage and administer it on an ongoing basis has been limited by needs attendant to the scenarios described above.
Although several carriers have attempted expand from these traditional markets into the defined contribution plan market by offering some form of protection to participants, thus far they have been largely unsuccessful. There are over 30 million 401(k) plan participants alone—less than 20 thousand have coverage protecting 401(k) retirement benefits from disability (either employee paid or employer paid). None of these existing policies are provided within the 401(k) plans.
None of the carriers trying to enter into the disability coverage for defined contribution plan market have figured out what is required to offer coverage in the plan. None have figured out what it takes to offer disability coverage to all participants of defined contribution plans—either in the plan or external to the plan. None have identified what is required to efficiently deal with a all of the additional laws pertaining to the ongoing tax law and labor law qualifications of each type of qualified defined contribution plan.
Because a full knowledge of the rules is required in order to assure ongoing defined contribution plan compliance and qualification, none have been able to offer a disability product (either group or individual) to employers or employees other than on a basis where the rules can not be violated (i.e., outside of the plans to a small group of participants).
Under Internal Revenue Code Section 408, certain individuals with earned income are eligible to make contributions to various individual retirement accounts and individual retirement annuities. Eligibility rules differ depending upon the type of individual retirement account. For example, generally, anyone under the age of 70½ who earns income from employment may make contributions to a traditional individual retirement account (IRA). For a Roth IRA, contributions may be made as long as the individual has earned income and a modified adjusted gross income below certain thresholds.
Under current law each eligible person may contribute a maximum of $2,000 or 100% of compensation, whichever is less, to either a traditional or Roth IRA annually (or split the maximum between plans, e.g., $1,000 to each).
Contributions to traditional IRAs are fully tax-deductible for federal income tax purposes if neither the individual nor their spouse is an active participant in an employer-sponsored qualified retirement plan. The deduction is reduced or eliminated if the individual's modified adjusted gross income exceeds certain thresholds.
Roth IRA contributions are not deductible for federal income tax purposes. However, withdrawals from Roth IRAs that begin after age 59½ are tax-free provided the Roth IRA has been established for more than five years.
Traditional IRA distributions may start after age 59½ and must start no later than age 70½. Withdrawals made prior to age 59½ are generally subject to a 10% penalty tax in addition to income tax. Exceptions to the penalty tax are made for certain distributions. Examples include but are not limited to the following:                Taken in substantially equal amounts over the individual's life expectancy        Occur due to the disability of the owner of the IRA        Are used to pay medical expenses in excess of 7.5% of ADI        
As noted above and clearly stipulated in Internal Revenue Code Section 408, both traditional and Roth IRAs are primarily intended as retirement savings accounts. Furthermore, traditional IRAs only provide favorable federal income tax deductions to those individuals who are not participants in employer-sponsored qualified retirement plans. Deductions are limited or offset completely if current earned income exceeds certain thresholds.
Individuals who are relying upon IRAs as a primary source of retirement income are generally the same people depending upon social security as another prime source of retirement income. Stated differently, people who work for employers sponsoring qualified retirement plan(s) are less dependent upon social security or IRAs for retirement income than people who work for employers offering no retirement plan(s). Even if the current law is liberalized to provide tax savings or incentives to individuals covered by private pension plans, there is a need to assure that targeted savings at retirement are not compromised due to unforeseen circumstances such as disabilities.
Additionally, many employer-sponsored qualified retirement plans provide employee participants certain safeguards with respect to the amount of retirement benefits available at retirement. For example, defined benefit pension plans are qualified retirement plans with employer contributions aggregated annually based upon an actuarially determined plan liability. Current contributions are generally based upon estimates of future employee income levels immediately prior to retirement (e.g., 50% of the final five years' average gross salary) and other actuarial factors such as estimated rates of return on plan assets, liability discount rates, employee turnover, mortality and morbidity. In contrast, benefits under defined contribution plans and hybrid plans such as Cash Balance plans are based upon individual accounts.
Sometimes defined benefit plans provide a disability protection provision. In the event the employee plan participant becomes disabled prior to retirement, the plan continues to accrue benefits as though the employee continued active employment. Hence, the income payable at retirement approximates the retirement income benefit payable had disability not interrupted the active employment of the plan participant.
Defined contribution plans such as 401(k) plans and non-traditional defined benefit plans such as cash balance plans are becoming increasingly popular. These plans are beginning to offer new forms of protection to disabled employees as well. (Note again the claim of priority and incorporation by reference of U.S. patent application Ser. No. 08/936,037 regarding a method for making such coverage more widely available.)
Private disability coverage, whether sponsored by employers or purchased directly by individuals have overall coverage limitations. Generally, the available coverage is limited to no more than 66⅔% of gross earned income. Insurance companies can be reluctant to provide a higher percentage of coverage due to the risk that a disabled insured will have insufficient economic incentive to go back to work. Often, the percentage of gross earned income covered is considerably lower than 66⅔%. This is because there are generally upper limitations on the amount of compensation covered (expressed in dollars, e.g., $200,000) or because only certain types of income are covered under disability policies (e.g., employer sponsored group long term disability insurance often excludes incentive compensation, commission income and other non-salary compensation from the definition of covered income). Because people who have private disability coverage are likely to receive 66⅔% or less of pre-disability income during disability, they are unlikely to be able to continue contributing to IRAs at pre-disability levels without worsening their present financial hardship.
Of course, millions of Americans have no private disability coverage at all, and social security provides a modest disability benefit, but has an extremely difficult definition of disability qualification to meet. Continuing IRA contributions at pre-disability levels will likely be the least of the financial worries for those who do not own private disability insurance.
Currently, insurance or benefits designed to make up for lost contributions (and the earnings thereon) to traditional IRAs or Roth IRAs resulting from the disability of individual account holders does not exist. There are no known products (insurance or other) on the market that provide this benefit.
Traditional disability income policies pay benefits during the time the person is disabled. Traditional policy designs that pay benefits during the period of disability necessitate disability benefits being paid either; 1) directly to the disabled IRA participant; 2) into the IRA of the disabled participant, or, 3) into some other accumulation vehicle. The purpose of the desired coverage is to prevent diminishment of retirement benefits that would have been accumulated or received had a disability not occurred. It is undesirable for the benefits to be at the immediate disposal or discretion of the disabled participant when the disability occurs. Firstly, the combined coverage may exceed the intended maximum of the insurance company or other benefit provider. For example, as stated previously, most insurers offering individual or group Long Term Disability (LTD) insurance seek to avoid coverage exceeding 66⅔% of compensation. Also, the participant may squander the benefit on current expenses and still suffer diminishment of retirement benefits.
There is a danger that the participant will squander benefits prior to retirement even if the benefit is payable to the IRA instead of to the participant. This is because Internal Revenue Code Section 408 specifically requires that disabled participants be able to access IRA plan assets prior to age 59½ without excise tax in the event of the disability the IRA owner. This provision of IRC Section 408 may explain why annuities sold as qualifying IRA plans have generally not included a “waiver of premium” option. A waiver of premium is an optional feature or rider offered in connection with certain life insurance and or annuity policies whereby premiums are waived under the contract during a qualifying disability. If a traditional waiver of premium approach is used with an IRC Section 408 qualified IRA, benefits (premiums waived plus earnings) must be accessible to the disabled participant immediately. There is therefore no assurance that benefits will not be diminished at retirement. There is also the possibility that the level of combined currently available disability income benefits will exceed the targeted maximum of the issuing insurance companies.
Making the benefit payable to a trust, annuity or other instrument may address this problem. The vehicle must possess the necessary restrictions on withdrawals prior to retirement to assure benefits are ultimately available at retirement. If this approach is used, the applicable taxation of the accumulation vehicle must be taken into consideration. Traditional IRA contributions are sometimes deductible. In addition, the growth (income and gains) of invested contributions is not subject to income taxation until distribution. If the disability benefit is contributed into a vehicle with either nondeductible contributions or currently taxable investment growth, the participant will suffer diminishment of retirement benefits. Because each participant's income tax bracket and situation may differ, this raises an almost infinite number of necessary corrective adjustments to offset the cost of taxes. Deferred annuities are not subject to income taxation on growth until distribution. However, in order for an annuity to completely avoid diminishment, the disability benefit must be grossed up so that the net after tax benefit matches the pre-disability contribution amount (an infinite number of possible corrections). If the disability benefit is paid into a deferred annuity on a tax-free basis, adjustments for non-deductibility may not be necessary. An annuity may also be desirable because some deferred annuities allow contract owners to direct investment options. This may allow the disabled participant to control annuity investment allocations in a fashion similar to IRA plans. However, we believe there are practical economic drawbacks to all of these approaches. Given that the maximum annual IRA contribution for an individual under current law is only $2,000 ($5,000 under proposed legislation), the cost of having dollars flowing into either a trust or annuity with special restrictions, is likely to be prohibitive in relation to the benefit. This may set the stage for a lack of availability of such a plan in connection with IRAs today. Plans using this approach are available in connection with replacing lost contributions to private pension plans (where the annual contribution limits are currently five times higher than for IRAs).
A possible alternative to deferred annuities or other accumulation vehicles that contain restrictions on plan withdrawals prior to retirement, is the disability policy or benefit itself. In order to avoid the diminishment risk described in the proceeding paragraphs, a disability policy or benefit would have to be designed with disability benefit payouts deferred until retirement or other specified time. Additionally, the policy must provide a method of making up for lost asset growth on contributions or hypothetical contributions. This might be accomplished in a number of ways. The policy or benefit could have a stated asset growth rate that the insurance company accrues on contributions and account balances until retirement (at the insurance company's risk). For example, the policy may promise that the annual contribution and account balance will grow at a specified rate (e.g., 8% per annum). If the insurance company earns less than 8% on its reserves, they are still obligated to pay benefits at 8%. If it earns more than the stipulated minimum return, it may either keep the excess return as profit (non-participating policy) or share the excess return with policy-owners in the form of dividends (a participating contract). Instead of a fixed rate of growth, the rate credited to accrued contributions and account balances may be tied to a published index such as a United States Treasury Bond Index or the Standard & Poors 500 Index. Once again, the insurance company may take the risk associated with delivering benefits at the promised growth rate and may issue the policy either on participating or non-participating basis. All of the designs mentioned thus far are examples of general account policies. All policy reserves are held within the general account of the insurance company and are general obligations of the insurance company. Insurance companies might also design a disability policy with policy reserves held in a separate account. The benefit obligations of these policies are supported by the underlying assets held within the separate account and is not a general obligation of the insurance company. Assets held in the separate account are reserved for the exclusive benefit of policyholders and are not chargeable with any other obligation of the insurance company. Annual accrued benefit contributions and account balances within both general account policies and separate account policies may be allocated by participants (generally, among several investment divisions). Under this approach, the investment risk associated with investment performance is borne primarily by each disabled participant (as opposed to the insurer).
Individuals can voluntarily purchase the various disability policy or benefit designs described above or coverage may be made available on some other basis. The financial institution offering a particular IRA product could offer the feature at no charge as a means of competing against other commercial IRA providers. Investment product vendors such as mutual fund companies may incorporate a disability completion feature within certain mutual funds and absorb the cost of providing the feature. They can also offer the feature as an optional benefit and charge higher fees. Insurance companies might provide an annuity with a similar feature or rider and either charge an additional fee or premium or absorb the cost. Employers might pay for a benefit, either insured or otherwise, on the behalf of employees. This is more likely in those situations where an employer makes an IRA available to employees under a payroll deduction plan or on some other sponsored basis.
The form or design of coverage or benefits can vary greatly. Group or individual disability policies may be used. It may be offered through a rider to some other form of insurance policy. The benefit may be provided as an implicit feature or provision of an account or other investment vehicle. The investment vehicle or account in turn might purchase insurance to indemnify all or a portion of the risk. Benefits can be paid in installments or in a lump sum.
Because there are currently no known disability policies or benefits on the market that defer disability benefit payments until retirement (or early retirement), there are no known computer software systems in existence (with the exception of the above-referenced Ser. No. 08/936,037) to track deferred disability payments, benefits, account balances, reserves or obligations. There are no known computer software systems available to track the growth or hypothetical growth of deferred disability benefits at either fixed rates or rates tied to indices with the risk for attaining such growth borne by the insurance companies (either with a participating policy or a non-participating policy), reinsurance companies, mutual fund companies or any other company. There are currently no known systems available to track the growth of deferred disability benefits with the growth of the deferred disability benefits tied to investment options selected by the disabled participant with the investment risk borne by the participant. There are no known computer software systems that calculate reserves, profits, losses, loss ratios, liabilities, or other actuarial factors for disability policies or benefits with benefits deferred until retirement or other specified period. There are no known computer software systems designed for primary insurance companies (insurance companies issuing the deferred disability policy) designed to interact on an automated basis with the computer software systems of reinsurance companies reinsuring deferred disability coverage. There are no known computer software systems available to provide accounting, record keeping or other administrative processes to insurance companies, reinsurance companies, mutual fund companies or any other company desiring to offer disability policies with benefits that are deferred until retirement or early retirement.
In our previous patent application (U.S. patent application Ser. No. 08/936,037), we identified a need for disability coverage protecting retirement benefits of individual participants within certain retirement plans qualified under Internal Revenue Code Section 401(a). We also stated that it may in some instances be preferable to provide such coverage on a deferred basis (deferred until retirement or early retirement). Except for our subsequently discussed invention, we know of no one else who has identified one other potential need to defer the payment of disability benefits until retirement or early retirement in connection with retirement plans qualified under Internal Revenue Code Section 401(a), as follows. Many employers offer two or more retirement plans to employees that are qualified under IRC Section 401(a). In such cases, the employer may wish to provide coverage to protect the contributions made on behalf of individual participants who are participants in more than one plan. In such cases, it may be undesirable to purchase two or more separate policies (one in each of the plans qualified under Internal Revenue Code Section 401(a)) for each participant. This would likely involve unnecessary duplication of certain expenses such as policy administration fees. It would be more economical to purchase a single policy covering all contributions, or an approximation of all contributions made on behalf of a single participant in two or more retirement plans qualified under Internal Revenue Code Section 401(a). This will require placing such coverage in a single retirement plan qualified under Internal Revenue Code Section 401(a). Payment of such consolidated coverage at the time of disability may not always comply with funding limitations for the selected plan. Therefore, it may be necessary to pay such benefits directly to the participant at retirement or early retirement (or the accrued benefit to a beneficiary in the event the participant dies during such period). In making the subsequently discussed invention, we believe that we are the first to have discovered this need or problem.
In recent years, politicians and others have opined that the current U.S. social security retirement system is heading toward fiscal crises. Some believe that the financial danger is attributable to both the changing demographics of the working population (the ratio of people who are employed to the people who are receiving social security retirement benefits has been steadily dropping for decades) and the low investment performance of current social security plan assets.
Historically, social security has not maintained or administered individual retirement accounts. Rather, aggregate plan liabilities determine aggregate funding goals.
In recent years, there have been several federal legislative proposals to reform the U.S. social security retirement system. Among these proposals are plans calling for the establishment of individual social security retirement accounts. Under one recent proposal, workers would be able to select investment options by filling out forms filed with their taxes. Although such plans are not yet in operation for U.S. workers, the present invention is useful for such accounts for workers of those nations that currently provide social security retirement plans with individual plans, and of course the computing for such accounts can be carried out anywhere (such as in the United States).
In light of the future financial problems of the current U.S. social security retirement system, legislation reforming the current system seems almost unavoidable. Currently, social security disability benefits are not based on individual retirement accounts. If legislation is passed that includes the establishment of individual social security retirement accounts, there will be an analogous need for entirely new type(s) of disability benefits protecting retirement benefits. (Note that the present invention is directed to computing operations, such that a particular embodiment of the invention and program code and/or data may reflect changeable but readily discernable matters from whatever facts or law may be applicable, U.S. or otherwise.)
There are many possible ways of preserving individual social security retirement account benefits in the event of disability.
In the case of individual social security retirement accounts, the cost and amount of coverage and benefits may be calculated individually based upon individual contributions or individual account balances. The cost of the benefit may be charged according to individual coverage amounts or may be assessed according to other factors. It may be insured through private insurance companies or self-insured by the Social Security Administration (used herein as an example but intended to encompass the like). If self insured, it may be self-insured through the establishment of a special fund or reserve or the risk can be borne by the system in some other fashion. The Social Security Administration might purchase insurance to indemnify all or a portion of the risk. If insured by private insurance companies, a group policy might be used. Benefits may be deferred until normal retirement or be payable at a special early retirement date. It is possible that both current and deferred benefits may be offered. Current and or deferred benefits might be linked to other social security disability benefits or may be calculated and funded separately.
The existing Social Security Administration computer software system(s) doesn't administer (record, process, measure, facilitate, manage, etc.) disability benefits based upon individual social security retirement accounts because the system doesn't maintain individual retirement account records at all. In fact, currently no known computer software system exists to administer individual social security retirement accounts. A private study (see “Study Finds individual Account Costs Can Be Small” in Defined Contribution News Mar. 29, 1999 Vol. Vii, No. 7) was recently completed by Fred Goldberg, former Internal Revenue Service Commissioner, to assess the cost and feasibility of the creation of a computer system capable of administering approximately 130 million individual social security retirement accounts. While the study was optimistic regarding the cost and feasibility of a computer system to administer such accounts, no such system currently exists. More recently, the Employee Benefit Research Institute (EBRI) published a book titled “Beyond Ideaolgy: Are Individual Social Security Accounts Feasible?” The book is the compilation of the writings and research of 24 distinguished authors. The entire book is dedicated to the questions of whether a system can be developed to administer individual retirement accounts for 148 million workers, and if so, to identify the logistics for implementing and administering such a gargantuan plan. Most of the authors agree that it is feasible, however, there is considerable disagreement as to the feasibility of certain approaches. Although the book is over 200 pages long and provides detailed lists and descriptions of complex tasks a system would have to perform to administer several possible plan designs, there is not a single mention of the need to administer disability benefits as an element of the individual accounts.
These aspects of our subsequently discussed invention are believed to be representative of the background of the invention so far as we know and subject to correction.